What is Social Finance?

March 10, 2014

The Center for American Progress has recently published a primer on various types of social finance, which are new funding mechanisms where evidence, evaluation, and capital are brought to bear on important social issues.

Written by Sonal Shah and Kristina Costa, the primer focuses on three avenues for social finance today: new methods of grantmaking, such as the White House's Social Innovation Fund; innovative public-private partnerships, such as social impact bonds; and new strategies and behaviors in the capital markets, such as impact investing.

Innovation funds are meant to address difficulties that many nonprofit organizations have in securing multi-year funding commitments from philanthropic institutions and public funding agencies, as well as the resources needed to scale programs that are clearly working.

One such example is the White House Social Innovation Fund, which was established by President Obama as a funding mechanism to help successful organizations scale their programs with the promise of grants between $1 million and $10 million per year for up to five years. And, because these grants must be matched dollar for dollar with private resources, the $137 million awarded by the Social Innovation Fund since 2010 has leveraged $350 million from other funding sources.

Similar innovation funds exist at the U.S. Department of Education and the U.S. Department of Labor, and the concept is being embraced by private foundations and corporations as a way of making longer term commitments and helping organizations scale their successful programs.

Impact bonds are not really "bonds" in the sense of a traditional, fixed rate security, but the authors describe them as "rigorous, outcome-based contracts between multiple parties." At the outset of the agreement, a public agency determines a specific, measurable outcome that they want to see improved (e.g., reducing the infant mortality rate) where the anticipated outcome will save the public sector money. Those anticipated future savings are used to calculate the price that the public sector is willing to pay for the improved outcome.

The public agency then contracts with an external organization that promises to achieve the outcome, and the organization seeks a private investor (which could be a foundation or corporation) that is willing to provide the working capital needed. If the desired outcome is achieved, the public agency releases the payment to the external organization who then repays the investor. If the outcome isn't achieved, the public agency doesn't make the payment and the investor is not repaid.

While social impact bonds have gained popularity in Europe, there are very few examples of them here in the United States. In fact, the first one in the U.S. was announced last August in New York with the goal of reducing recidivism among young people at Rikers Island prison by 10 percent over four years. This impact bond was financed by Goldman Sachs, but was guaranteed with a grant from Bloomberg Philanthropies for 75 percent of the total investment, thus lessening the risk to the investor.

Impact investing harnesses the capital markets to invest in businesses that seek to achieve "double-bottom-line" results blending financial and social benefit with the intention of making a positive impact. This kind of investing can take several forms. Some states have passed laws creating a new class of private enterprise called "benefit corporations" or "B Corps." These companies operate like traditional businesses, but obtain special social certifications. Other businesses build social impact into their brand image and promotions.

Examples of social impact businesses or social enterprises are Warby Parker (the online eyeglass retailer), Revolution Foods (makers of healthy school lunches), Starbucks, Unilever, Patagonia and Ben & Jerry's. These companies are profitable, but they are also explicitly promoting their sustainability or socially responsible practices.

(American Express has teamed up with Ashoka to help train the next generation of social entrepreneurs through our Emerging Innovators Boot Camps in New York, Toronto and Mexico City. In addition to emerging leaders trained directly through the workshops, an additional 3,000 leaders have been impacted through Twitter chats and streamed programs. Likewise, we've worked with Ashoka to provide pro bono consulting services to social enterprises in Argentina, Canada, India, Mexico and the U.S.)

These emerging social finance tools promise new ways of stabilizing and scaling social programs that work and have real impact in communities. And, this primer goes a long ways toward demystifying many of the complexities of these new funding models.

What do you think? Do these new funding mechanisms make sense to you? We would love to hear your points of view. Please click here to share your comments. Alternatively, follow me on Twitter at @timmcclimon and comment there.

P.S. Did you know that the UK has taken the lead in providing the ecosystem and funding needed for social finance and impact bonds? Its Big Society Capital and Centre for Social Impact Bonds are well-funded mechanisms for facilitating social financing arrangements.

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